Could a contractor remove untaxed purchases and penalties from its Virginia use-tax audit?

Plain-English summary

Virginia did not remove four construction-material purchases from the use-tax audit because the contractor's documents did not reconcile to the exception list. A contractor or subcontractor that furnishes and installs materials becoming real property is generally the taxable user and consumer of those materials.

The contractor claimed its subcontractor had installed the items and paid the tax. Virginia gave the contractor 45 days to submit records matching the audited purchase amounts. Without reconciled documentation, the assessment would remain due.

The compliance penalty also remained. This was the contractor's fourth audit, its use-tax compliance ratio was 7%, and the regulation's third-and-later-audit threshold was 85%. The contractor showed no exceptional mitigating circumstances.

Virginia also upheld the 20% post-amnesty penalty because the audit included eligible periods ending on or before May 31, 2009 and the compliance penalty was properly applied.

What this means for you

• Contractors should determine who is the taxable user of materials under each furnish-and-install contract.
• Proof that another party paid tax must reconcile invoice by invoice with the audit exception list.
• Repeat audits carry higher compliance expectations and make penalty relief harder.
• Virginia's post-amnesty penalty can apply in addition to other audit penalties for eligible historical periods.

Common questions

Q: Did Virginia reject the subcontractor-payment claim permanently?
A: It rejected the existing documentation but allowed 45 days to provide records that reconciled to the four purchases.

Q: Why was the compliance penalty upheld?
A: The fourth-audit use-tax compliance ratio was 7%, far below the 85% threshold, and no exceptional mitigating circumstances were shown.

Q: Was the post-amnesty penalty separate?
A: Yes. The ruling described it as an additional 20% penalty on qualifying unpaid tax.

Citations and references

• 23 VAC 10-210-410 A and 10-210-2032 A.
• Va. Code §§ 58.1-635 and 58.1-1840.1.

Subject

Construction materials purchased untaxed tax not paid to Department

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 13-45

Original ruling text

March 29, 2013

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 * (the "Taxpayer"), for the audit period March 2008 through January 2011.

FACTS

The Taxpayer operates as a general contractor. The Department's audit disclosed that the Taxpayer purchased construction materials without payment of the tax to suppliers or accrual and payment of the tax to the Department. The Taxpayer is in agreement with the audit results with the exception of four purchases, stating that the subcontractor was responsible for and paid the tax to the Department. The Taxpayer has submitted documentation supporting its position that the tax was paid by the subcontractor. Accordingly, the Taxpayer requests an adjustment of the Department's assessment for the purchases at issue, as well as a waiver of the assessed penalties.

DETERMINATION

Use Tax

When a transaction requires a contractor or subcontractor to furnish and install items that become real property upon installation, such contractor or subcontractor is deemed the taxable user and consumer of any and all items furnished and installed pursuant to such real property installation contracts. See Title 23 of the Virginia Administrative Code (VAC) 10-210-410 A.

In this instance, the Taxpayer states the purchases of the tangible personal property at issue were installed by the subcontractor and the submitted documentation reflects that such taxes have been paid. The Department's auditor reviewed the purchases listed in the Department's assessment and determined that the Taxpayer was purchasing tangible personal property for its own use and consumption. The Department's auditor has also conducted a review of the information provided by the Taxpayer and determined that the documentation does not reconcile with the amounts reflected on the purchases exception list. Accordingly, there is no cause to revise the Department's assessment for the contested purchases. I will, however, allow the Taxpayer 45 days to present documentation that reconciles with the listed purchases. If not presented to the auditor within that time, the Department's assessment will be considered correct as assessed and the balance will become due and payable.

Compliance Penalty

The Taxpayer requests waiver of the use tax compliance penalty assessed in the audit. This was the Taxpayer's fourth audit.

Virginia Code § 58.1-635 mandates the application of penalty to tax deficiencies. Title 23 VAC 10-210-2032 A states, “The application of penalty to audit deficiencies is mandatory and its application is generally based on the percentage of compliance determined by computing the dealer's compliance ratio." With regard to third and subsequent audits, the regulation states that penalty will generally be applied unless the taxpayer's use tax compliance ratio meets or exceeds 85% for sales tax and 85% for use tax. For this audit, the Taxpayer's use tax compliance ratio is 7%. Because the Taxpayer failed to meet the required 85% use tax compliance ratio for a fourth generation audit, the compliance penalty was properly applied.

Title 23 VAC 10-210-2032 also states that the application of penalty to audit deficiencies will not be waived on second and subsequent audits for "other than exceptional mitigating circumstances." The Taxpayer has not presented evidence of exceptional mitigating circumstances that warrant waiver of the penalty. Accordingly, the Taxpayer's request for abatement of the compliance penalty is denied.

Post-Amnesty Penalty

Virginia Code § 58.1-1840.1 established the Virginia Tax Amnesty Program providing that:

If any taxpayer eligible for amnesty under this section and under the rules and guidelines established by the Tax Commissioner retains an outstanding balance after the close of the Virginia Tax Amnesty Program because of the nonpayment, underpayment, nonreporting or underreporting of any tax liability eligible for relief under the Virginia Tax Amnesty Program, then such balance shall be subject to a 20 percent penalty on the unpaid tax. This penalty is in addition to all other penalties that may apply to the Taxpayer.

Because the audit at issue covered Amnesty-eligible periods (taxable periods ending on or before May 31, 2009), and a compliance penalty was properly applied, the Post-Amnesty penalty was also properly assessed.

The Code of Virginia sections and regulations 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 matter, please contact * of the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5212987547.Q