I mistakenly charged sales tax instead of paying use tax as a contractor — now that Virginia law changed in 2024, can I get credit for the sales tax I already collected and remitted against my use tax assessment?

Plain-English summary

A custom metal fabricator — providing millwright services, crane services, design and layout services, plant maintenance, and finished materials used in real property contracts, plus some finished metal fabrication sold without installation — was audited for July 2015 through December 2019. It had treated itself as a retailer for sales and use tax purposes, collecting and remitting sales tax based on the price of what it sold. The auditor instead treated it as a fabricator working primarily for its OWN use in real estate installation contracts, and assessed use tax on untaxed purchases of tangible personal property. The Taxpayer challenged the assessment on two fronts: first, that it was properly classified as a retailer all along; second, in the alternative, that it should get credit toward the use tax assessment for the sales tax it had already charged, collected, and remitted from its customers.

Contractor vs. retailer — the dual-operator problem. Under Virginia Code § 58.1-610 A, a business that contracts to install tangible personal property into real estate is generally deemed to have purchased those materials for its OWN use — it owes sales tax on the materials, not a separate collected tax on the installed job (23 VAC 10-210-410 A). But because this fabricator ALSO sold some finished items at retail without installing them, it was a "dual operator" under 23 VAC 10-210-410 E, governed by a primary purpose rule keyed to gross receipts: mostly retail sales means buying materials tax-exempt for resale and only accruing use tax when inventory is pulled for the fabricator's own installation jobs; mostly installation work means paying tax up front on materials and separately collecting/remitting tax on anything actually sold at retail; and if the split genuinely can't be determined, a direct payment permit under § 58.1-624 is available. Here, the Department's review of the Taxpayer's books found most fabricated items were used or consumed in installation for customers, so the auditor correctly classified the Taxpayer as a contractor fabricating principally for its own use (citing P.D. 96-274) — meaning the Taxpayer should have paid sales tax to its own vendors on materials rather than collecting sales tax from its customers, and the untaxed material purchases were properly assessed as use tax exceptions.

The credit question — where this ruling breaks new ground. Historically, the Department's policy has been NOT to credit a contractor's erroneously collected-and-remitted sales tax against a related use tax assessment, since the two are treated as separate transactions (23 VAC 10-210-3040; P.D. 07-135, which overruled an earlier, more permissive P.D. 03-87). A contractor in that position was generally limited to seeking a REFUND of the erroneously collected sales tax, and only if it could show the tax wasn't passed on to the customer or was refunded to the customer — narrow exceptions existed for cases where a customer had separately paid use tax on the same transaction (P.D. 07-68) or assigned refund rights to the contractor (P.D. 09-177). That changed with Virginia Code § 58.1-1812 C, effective July 1, 2024 (2024 Acts of Assembly, Chapters 113 and 128): it now permits the Department to credit a contractor's erroneously collected-and-remitted sales tax against a use tax assessment on the SAME specific property, but only as a ONE-TIME credit for the taxpayer's first offense, and only if the contractor can clearly show the identical property was both taxed at sale and subject to use tax. Virginia Tax Bulletin 24-3 (P.D. 24-64) implements the new law; audits completed on or after July 1, 2024 have auditors determine the credit directly, while assessments made BEFORE that date — like this one — require the contractor to file Form OIC B-2 (an offer in compromise) to claim it.

Outcome: sent back for review, not decided here. Because the Taxpayer's correction request was filed before VTB 24-3 was issued but specifically requested credit under the new § 58.1-1812 C, the Department returned the case to field audit staff to evaluate the Taxpayer's eligibility for the one-time credit and adjust the assessment if warranted — rather than granting or denying the credit in this ruling itself. Any credit granted would extend forward to periods after the audit, until the Taxpayer fixed its accounting practices or the audit revision was completed, whichever came first. Going forward, as a contractor fabricating primarily for its own use, the Taxpayer should pay sales tax to its vendors (or accrue and remit use tax directly) rather than collecting sales tax from customers — or apply for a direct payment permit if its situation genuinely can't be sorted out purchase by purchase. The ruling notes this one-time credit will NOT be available again in future audits.

What this means for you

Fabricators and contractors who both sell and install their own work

Your tax treatment as a "dual operator" turns on which activity — retail sales or your own real-property installation — makes up the MAJORITY of your gross receipts, not on how you've been billing customers. Misclassifying yourself (as this taxpayer did, treating itself as a retailer when it was mostly a contractor) can leave you owing years of unpaid use tax on materials.

Contractors who discover they erroneously collected sales tax instead of paying use tax

As of July 1, 2024, Virginia Code § 58.1-1812 C gives you a real (though limited) escape valve that didn't exist before: a one-time credit for erroneously collected-and-remitted sales tax against a related use tax assessment on the same property — but it's first-offense-only, requires matched records proving the same specific property, and for pre-7/1/2024 assessments requires filing Form OIC B-2 rather than getting it automatically during the audit.

Accountants and tax professionals advising fabrication/contracting clients

If a client is mid-dispute over an old use tax assessment tied to erroneously collected sales tax, check whether § 58.1-1812 C and VTB 24-3 (P.D. 24-64) can now apply — this is new law that reverses decades of the Department's prior policy (P.D. 07-135's no-credit rule), so don't assume the old "no credit" answer is still the last word.

Common questions

Q: I fabricate items and sometimes install them myself — how do I know if I'm taxed as a retailer or a contractor?
A: It depends on which activity — retail sales or your own real-property installation — produces the majority of your gross receipts; that's the "primary purpose rule" under 23 VAC 10-210-410 E.

Q: I collected sales tax from customers on materials that were later assessed use tax in an audit — is that credited automatically?
A: Not automatically, and historically not at all. But under Va. Code § 58.1-1812 C (effective July 1, 2024), a one-time credit may now be available for the first offense if you can show the same specific property was both charged sales tax and subject to the use tax assessment.

Q: My audit was completed before July 1, 2024 — can I still get this credit?
A: Yes, potentially, but you'll need to file Form OIC B-2 (an offer in compromise) with matched purchase and sales records, rather than having the auditor apply it directly.

Q: Can I get this credit more than once?
A: No — it's limited to the taxpayer's first offense, and the Department has stated it won't be available again in future audits for the same taxpayer.

Citations and references

Statutes and regulations:

• Va. Code § 58.1-610 A — contractor deemed to purchase tangible personal property for its own use in real property contracts
• 23 VAC 10-210-410 A — tangible personal property incorporated into real property is used/consumed by the contractor
• 23 VAC 10-210-410 E — dual-role fabricators follow the primary purpose rule based on gross receipts
• Va. Code § 58.1-624 — direct payment permit when primary purpose can't be determined
• 23 VAC 10-210-3040 — refund of erroneously collected tax requires showing it wasn't passed on, or was refunded to the customer
• Va. Code § 58.1-1812 C — one-time credit for erroneously collected/remitted sales tax against a related use tax assessment, effective July 1, 2024

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 25-8

Original ruling text

January 15, 2025

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 2019.

FACTS

The Taxpayer, a custom metal fabricator, provides millwright services, crane services, design and layout services, plant maintenance services, and finished materials used in real property contracts. During the period indicated above, it also provided finished metal fabrication to customers without installation. For sales and use tax purposes, the Taxpayer treated itself as fabricator of tangible personal property for retail sale and collected and remitted tax based on the price of the sale.

The Taxpayer was audited for the period at issue. Based on the Taxpayer’s operations, the auditor treated the business as a fabricator of tangible personal property for its own use in real estate contracts. As a result of the audit, the Taxpayer was assessed use tax on untaxed purchases of tangible personal property. The Taxpayer filed an application for correction, contending that it properly classified itself as a retailer. In the alternative, the Taxpayer argues that it should be allowed a credit toward the use tax on tangible personal property provided in transactions for which it charged, collected, and remitted sales tax from its customers as permitted under newly amended legislation.

DETERMINATION

Contractors

Generally, real property contractors must comply with Virginia Code § 58.1-610 A, which provides:

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.

The regulation that interprets this provision, Title 23 of the Virginia Administrative Code (VAC) 10-210-410 A states:

Tangible personal property incorporated in real property construction that loses its identity as tangible personal property and becomes real property is deemed to be tangible personal property used or consumed by the contractor. Any sale, distribution, or lease to or storage for such a contractor is deemed a sale, distribution, or lease to or storage for the ultimate consumer (the contractor), and not for resale by the contractor.

Based on the facts in this case, the Taxpayer was fabricating property for both retail sale and for its own use as a consuming contractor. Under these operating conditions, the Taxpayer would be considered a dual operator.

Dual Operators

Title 23 VAC 10-210-410 E addresses fabricators who operate in a dual capacity of fabricating tangible personal property for sale or resale and fabricating for their own use and consumption in the performance of real property construction contracts. This regulation provides that dual role fabricators must follow the primary purpose rule based on gross receipts in determining sales and use tax application.

For the purposes of sales and use tax application, the primary purpose rule as applied to a dual capacity operator is as follows:

• If most of the gross receipts result from a fabricator’s sales or resales, it would purchase materials exempt from tax by submitting an appropriate exemption certificate to its vendors and would collect and remit the tax based upon the total amount for which the vinyl fencing is sold. When the fabricator withdraws tangible personal property from its inventory for use and consumption in the performance of real property construction contracts, it would accrue the tax based on the fabricated cost price of the inventory withdrawn and remit the use tax with its sales and use tax return.

• If most of the gross receipts result from fabricating products for its own use and consumption in real property construction, a fabricator would pay sales tax on all materials at the time of purchase to all suppliers that are authorized to collect the tax. In addition, a fabricator would also be required to register, collect, and pay the tax on the retail selling price of the fabricated products sold regardless of whether tax had already been paid to a supplier. The fabricator would be permitted to purchase exempt from the tax only those materials that could be identified at the time of purchase as purchases for resale.

• If the primary purpose cannot clearly be determined based on gross receipts or materials are purchased under circumstances where it is impossible to determine the manner in which such materials would be used at the time of sale, a fabricator may apply to the Department to pay any tax directly to the Commonwealth. See Virginia Code § 58.1-624 concerning direct payment permits.

The analysis of the Taxpayer’s books and records indicated that most of the fabricated items were used or consumed in building or installation for customers. Based on the primary purpose test, the Taxpayer incorrectly operated as a retailer during the audit period and the auditor properly classified the Taxpayer as a contractor fabricating principally for their own use based on the primary purpose rule. See also Public Document (P.D.) 96-274 (10/9/1996).

As a contractor fabricating principally for its own use, the Taxpayer was required to pay the sales tax to its vendors at the time of its purchases of tangible personal property consumed in its real property contracts. Instead, the Taxpayer erroneously treated its transactions as retail sales and charged the sales tax to its customers. Consequently, material purchases for which the Taxpayer did not pay the sales tax were properly listed as exceptions in the audit.

Credit for Improperly Charged Sales Tax

The Taxpayer asserts that it is entitled to a credit for the tax periods at issue in amounts greater than the use tax that was assessed. In essence, it is arguing that it has already collected and remitted sales tax, which allowed the Commonwealth to receive more tax than permitted by the existing sales and use tax statutes and regulations.

Historical Policy

When any contractor erroneously collects sales tax from its customers, it does not eliminate the contractor’s responsibility to remit use tax on the property being installed. See Title 23 VAC 10-210-410. Under audit, if it was determined that use tax should have been paid rather than the erroneously remitted sales tax, the contractor would receive an assessment for the unpaid use tax. Because the transaction on which the sales tax was collected is a separate transaction, credit has not generally been granted against the use tax assessment. The contractor is generally entitled to a refund of the sales tax only if he can show that the tax erroneously collected was paid by him and not passed on to the customer or that the tax was collected from the customer and subsequently refunded to the customer. See Title 23 VAC 10-210-3040

The Department’s current policy only permits a credit in limited circumstances. The Department has allowed credit in a case involving a dealer that incorrectly failed to charge sales tax, but the customer remitted use tax for the transaction. See P.D. 07-68 (5/10/2007). Similarly, in P.D. 22-56 (3/30/2022), the Department allowed credit where the contractor included "estimated use tax" on its invoice, essentially charging sales tax under the wrong name, but remitted the use tax for the property consumed in the transactions on its returns.

In P.D. 07-135 (9/4/2007), the Department reasoned that allowing a credit for erroneously collected sales tax would (1) authorize contractors to pay their use tax liability with their customer's sales tax payments, and (2) allow contractors to avoid financial responsibility for violating the requirements of Virginia Code § 58.1-610. In other words, the Department does not allow a credit based merely on the fact that the tax has been paid. Further, P.D. 07-135 overruled earlier cases, including P.D. 03-87 (11/12/2003), in which a contractor that incorrectly collected retail sales and use tax from Virginia customers and had not issued refunds to such customers was permitted a credit of taxes collected and remitted against use taxes assessed in the audit. In P.D. 09-177 (11/19/2009), the Department upheld the policy established in P.D. 07-135 but permitted a credit for tangible personal property included in transactions for which the customers had assigned the rights to refunds of erroneously paid sales tax to the consuming contractor.

Law Change

Effective July 1, 2024, Virginia Code § 58.1-1812 C, as amended by the General Assembly (2024 Acts of Assembly, Chapters 113 and 128), permits the Department to allow erroneously collected retail sales tax collected by a contractor from its customer and remitted to the Department to be credited against a use tax assessment made against such contractor regarding the transaction. Virginia Tax Bulletin (VTB) 24-3, issued as P.D. 24-64 (7/1/2024), provides important information concerning the new law.

Under Virginia Code § 58.1-1812 C, when a contractor has erroneously charged, collected, and remitted sales tax on transactions in which tangible personal property was installed and annexed into real property and the same tangible personal property is rightfully subject to a use tax assessment, a one-time credit for the erroneously remitted sales tax will be permitted against the use tax assessment. The credit will be limited to the use tax assessed on the contractor’s purchase transaction of tangible personal property and will be allowed for the first offense only. In practical terms, the first offense would be the first time the issue is identified on audit.

In order for a credit to be granted, a contractor must clearly show that the property included in transactions for which sales tax was erroneously collected and remitted was the same specific property that was incorporated into realty and subject to the use tax. However, credit will not be given in any case where the taxpayer has previously applied for and received such a credit, or in the case of a false or fraudulent action by the taxpayer with the intent to evade the proper tax.

For audits completed on or after July 1, 2024, audit staff will be required to determine the amount of the credit, if any. Auditors will need to have access to a contractor’s complete purchase and sales records in order to verify credit for tangible personal property for which use tax should have been accrued. If complete records are not available, auditors will work with contractors to find alternative means to verify a credit. In addition, auditors will extend the application of the credit forward in order to cover all periods in which the contractor erroneously collected sales tax. The credit is limited to the applicable use tax liability for the first offense.

For assessments made before July 1, 2024, a contractor will be required to complete and submit an offer in compromise request on Form OIC B-2 to initiate the process. A contractor will need to provide matched purchase and sales records as well as sales and use tax return detail to document its eligibility. A review of the offer in compromise may be conducted by office staff or referred to field audit staff depending on the nature and volume of the information provided.

In the alternative, contractors can receive a refund of any erroneous retail sales tax payments remitted if they can affirmatively show that the tax has been refunded to the Virginia customer or credited to their account. The contractor will need to follow the Retail Sales and Use Tax Refund Claim Procedures available on the Department’s website. A contractor will not be eligible for both the credit under Virginia Code § 58.1-1812 C and a sales tax refund on the same transaction.

CONCLUSION

As determined by the auditor, the Taxpayer was a fabricator for its own use that erroneously charged, collected, and remitted sales tax on its transactions that included installation into real property during the audit period at issue.

Under VTB 24-3, the Taxpayer would need to file Form OIC B-2 to initiate a claim for a credit toward its audit assessment or follow the procedures for claiming a refund for taxes erroneously collected from its customers. Because this application for correction was filed before the issuance of VTB 24-3 and it requests a credit in the manner permitted under Virginia Code § 58.1-1812 C, the audit will be returned to the appropriate field audit staff to review the Taxpayer’s eligibility for the one-time credit and adjust the assessment accordingly.

The credit will be extended to periods subsequent to the audit until the date at which the Taxpayer changed its accounting system to comply with Virginia retail sales and use tax requirements or the last day of the month following the month in which the revised audit is completed, whichever is earlier. The extension does not constitute an expansion of the audit period and is limited to the credit for erroneous collection of tax. A contractor and the auditor, however, may agree to bring the entire audit forward to correspond with the extension period.

After the revision of the audit is complete, the Taxpayer will be issued a revised audit report and revised bill, if applicable, with interest accrued to date. No further interest will accrue provided the outstanding liability is paid within 30 days of the date of the updated bill.

Because it primarily fabricates products for its own use and consumption, the Taxpayer should pay sales tax to its vendors or accrue and remit the use tax directly to the Department on its purchases of tangible personal property consumed in its real property contracts. In the alternative, the Taxpayer may be able to apply to the Department for a direct pay permit. If approved, the Taxpayer would file a Virginia Direct Payment Permit Sales and Use Tax Return (currently Form ST-6).

A credit for erroneously collected and remitted retail sales tax will not be available in future audits.

The Code of Virginia sections and regulations cited are available online at law.lis.virginia.gov. The public documents and tax bulletin cited are available at tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy and Legislative Affairs, Tax Adjudication and Resolution Division, at or **@tax.virginia.gov.

Sincerely,

James J. Alex

Tax Commissioner

Commonwealth of Virginia

Related Documents

96-274

03-87

07-68

07-135

09-177

22-56

24-3

24-85

24-85