By Terry Barrett, CPA
Tax practitioners tend to focus on their clients’ income tax issues. However, businesses these days find they are spending more and more time on sales tax, particularly if they are operating in multiple states. Forty-five states, including Virginia and the District of Columbia, impose some form of retail sales and use taxi, and the rules are generally different from state to state.
In addition, some local jurisdictions impose and administer their own sales and use tax. The local rules may not necessarily be the same as the state rules. Thus, compliance can be complicated for those operating in multiple states; however, operating only in Virginia can have its own complications. Read below for general information regarding Virginia’s retail sales and use tax laws and policies with an emphasis on common business purchases.
Overview of the Tax
In Virginia, the retail sales and use tax laws have not changed substantially over the years. The tax is imposed on retail sales, leases or rentals of tangible personal property and limited services, as well as services in connection with the sale of tangible personal property. Pure service transactions in which there are no tangible deliverables generally are not taxable. Unlike many states, Virginia has not expanded its tax base to include new (or old) services. That’s good for businesses, considering how once goods only available in tangible format (software, books and other information sources, etc.) that are taxable are now available in digital or electronic format (not taxable).
Virginia traditionally has provided exemptions from the retail sales tax to promote investment in certain industries, such as manufacturing, research and development, broadcasting and agriculture. More recent exemptions include certain purchases for use in data centers, spaceport activities, solar and wind energy production and commercial beer production. It is important to understand, though, that while the state provides exemptions for these and other industries/activities, those exemptions generally do not extend to all purchases and are strictly construed by the Virginia Department of Taxation (TAX).
For example, only those purchases by a manufacturer that are “used directly” in the manufacturing process are exempt from the sales tax. To gain a good understanding of the extent of the exemption, you must look at the definition of “used directly” in the Code of Virginia, read the regulation on manufacturing in the Virginia Administrative Code and read volumes of ruling letters issued by TAX. Research is especially important when seeking guidance on technologies that were not even conceived when TAX last revised its manufacturing regulation in 1985.
What’s Included in the Taxable Base?
There is often confusion regarding what charges by a retailer are taxable. The retail sales tax is imposed on the “sales price” of the taxable good or service. According to the Code of Virginia, “sales price” is defined by law as “the total amount for which tangible personal property or services are sold, including any services that are part of the sale, … 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.” There are certain deductions from the “sales price” also detailed in the Code, such as the trade-in value, cash discounts allowed, finance charges, carrying charges, service charges or interest from credit extended on sales of tangible personal property under conditional sale contracts or other conditional contracts providing for deferred payments of the purchase price, separately stated local property taxes collected, discretionary gratuities added to the price of a meal and mandatory gratuity or service charge added by a restaurant to the price of a meal provided that gratuity does not exceed 20 percent of the price of the meal.ii
As noted above, included in the taxable sales price are any services that are part of the sale of tangible personal property, unless there is an exemption in the law for such services. For example, if one purchases computer hardware and has the seller train office personnel on the use of the hardware, any training fees that are contracted for in connection with the purchase of the hardware are taxable even if separately stated on the customer’s invoice. Late payment and returned check fees are examples of taxable service charges in connection with the sale or lease of tangible personal property.
Similarly, travel reimbursement charges (hotel, meals, mileage, etc.) and “trip charges” related to the sale and installation of taxable tangible personal property are taxable, even if separately stated on an invoice, as they are considered part of the selling price of the tangible personal property. However, according to rulings from the Virginia tax commissioner, those same charges are exempt from the tax if the purpose of the trip is merely to provide exempt services to customers.iii
Some services that typically appear in connection with the sale of tangible personal property are specifically exempt by law, including certain delivery and installation charges. Shipping, transportation and delivery charges from the seller to the customer are exempt from the tax if they are separately stated on an invoice. However, “shipping and handling” charges, even if separately stated on an invoice, are taxable if made in connection with the sale of a taxable good. The handling component is considered a service and results in the “shipping and handling” charge being taxed. Also, to the extent shipping charges do not reasonably represent the actual shipping charges —in other words, they are marked up — these will be considered taxable by TAX. If billed lump sum, though, they are taxable. It is noteworthy that installation charges in connection with exempt items are exempt regardless of how stated on an invoice.
What’s Taxable Among Common Business Purchases?
The following summarizes the tax treatment of some common business (and individual) purchases:
Computer Hardware, Office Equipment, Office Supplies
Because these all are tangible personal property, they generally are subject to the retail sales tax, whether purchased or leased.
Computer Software and Software-Related Services
Canned or off-the-shelf software is taxable if delivered in tangible format (e.g., on a CD). However, if it is delivered via email or a key is supplied that facilitates a download, the software is not taxable (as long as no tangible back-up is provided with it). License fees or “software maintenance” fees that include periodic updates generally follow the taxability of the original purchase, according to the Code and tax commissioner rulings.iv Thus, substantial tax savings can be achieved by purchasing software that is delivered electronically. It is important, though, to ensure that any documentation, including the invoice and contracts relating to the software purchase, indicate the software is delivered electronically and no tangible product is provided. Do not accept documentation from a vendor that states the software may be delivered electronically or in tangible format. A Virginia auditor will jump all over that.
Custom software is not taxable regardless of the method of delivery. However, to be considered “custom” software in Virginia, it truly must be developed from “scratch.” By law it must be specifically designed and developed only for one customer. The Code says the combination of two or more prewritten programs, or the modification of a prewritten program, do not constitute a custom computer program.v Separately stated charges for modifications to canned software and custom software are exempt from the tax, however.vi
Software maintenance charges that include periodic updates and technical support generally follow the original purchase. If the original purchase was in tangible format, the maintenance is generally taxable on 50 percent of the sales price; however, if the original purchase was in electronic format and subsequent updates are in electronic format, the maintenance charges are not taxable.
Software as a Service and other Similar Electronic Software Platforms, Cloud Computing, Hosting Services
Virginia considers software as a service, cloud computing and website or software hosting services as exempt services as long as no tangible medium is provided to customers.vii
Digital Products and Database, Information or Subscription Services
Services not involving an exchange of tangible personal property which provide access to or use of the Internet or any other related electronic communication service, including software, data, content and other information services delivered electronically via the Internet are not taxable.viii This includes virtually all digital products and content regardless of how you want to describe them, whether newspapers, magazines, eBooks, music, videos, movies, database services, subscription services or information services. However, if a tangible product is provided in connection with the digital good, the entire transaction may be taxable.
Food and Meals
Food purchased for home consumption is taxed at 2.5 percent statewide. This includes snacks, bottled water, coffee, tea and other items purchased at a grocery store for employees to enjoy at work. Catered meals, on the other hand, are taxed at the normal sales tax rate, and may also be subject to the local meals tax. Caterers must collect the meals tax based upon where their operations are and not where a customer is located. Discretionary tips are not taxable; however, mandatory tips that exceed 20 percent of the charge for the meal are taxable on that portion of the tip that exceeds 20 percent.
Maintenance Contracts
Although the law changed effective Jan. 1, 1996, there still is some confusion about the proper tax treatment of maintenance contracts. Here are the general rules:
- Maintenance contracts for real property (e.g., periodic maintenance or repair of elevators):
- These are not taxable to the consumer. The provider of the maintenance service is the taxable consumer of all materials used in providing the maintenance, whether supplies, repair parts or tools.
- Maintenance contracts for tangible personal property (e.g., computer hardware maintenance):
- If the contract covers both repair labor and parts (even if no parts are ever provided under the contract), the sales tax applies to one-half the total charge for the contract.
- If the contract is for labor only, it is not taxable.
- If the contract is for parts only, it is taxable in full.
- Maintenance contracts for exempt tangible personal property (e.g., manufacturing equipment, farm machinery, etc.) are not taxable.ix
Internet or Out-of-State Purchases
A purchase of a taxable item from an out-of-state or Internet seller is treated the same as if the purchase was made from an in-state retailer. The difference, though, is that the out-of-state or Internet seller may not collect the tax on the transaction. In this case, use tax should be self-assessed and reported by the business directly to TAX. This includes purchases made with company procurement or credit cards. Receipts should be maintained to document that the tax was paid or the transaction was not subject to the tax. Virginia auditors tend to focus on these types of purchases. Keep in mind that while Amazon does collect the tax on sales made to Virginia consumers, third-party sellers who sell through Amazon may not collect the tax unless required by law.
It is noteworthy, too, that some in-state vendors may not collect the proper amount of tax. Common errors are with “shipping and handling” charges and services in connection with the sale of taxable tangible personal property. In these instances, a business should self-assess and report use tax directly to TAX. Some businesses erroneously think that if the tax is not charged by the seller, whether in-state, out-of-state or online, it is not due.
Terry Barrett, CPA, is a tax senior manager at Keiter in Glen Allen. Terry focuses on state and local tax consulting and primarily non-income tax issues, such as sales and use tax and business license and personal property tax, in Virginia and other states.
i Note: Throughout the article, “sales tax” generally refers to the retail sales tax. In Virginia there are other sales taxes, like the motor vehicle sales tax (imposed on motor vehicle sales), the aircraft sales tax (imposed on aircraft), a watercraft sales tax (on watercraft), a communications sales tax (on telecommunications services), etc.
ii Code of Virginia §§ 58.1-602 and 58.1-603.
iii Ruling of the Tax Commissioner PDs 96-88 (5/14/96) and 12-215 (12/21/2012).
iv Code of Virginia § 58.1-609.10 4; Ruling of the Tax Commissioners PD 99-283 (11/14/1999); PD 01-61 (5/5/2001).
v Code of Virginia § 58.1-602.
vi Code of Virginia §§ 58.1-609.5 6 & 7.
vii Ruling of the Tax Commissioner PDs 12-191 (11/29/2012) and 12-215 (12/21/2012).
viii Code of Virginia § 58.1-609.5 1.
ix Tax Bulletin 95-8, Virginia Department of Taxation (9/27/1995).
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