I sold IT equipment to a government contractor who said it was buying as an agent of the federal government under a cost-reimbursement contract -- is that sale exempt from Virginia sales tax?

Plain-English summary

A government IT contractor provides consulting services and sells hardware and software to government agencies and other entities. An audit assessed sales tax on untaxed sales the taxpayer had treated as exempt. The taxpayer appealed on two separate grounds: that sales to one customer ("Customer 1") were exempt government sales, and that the audit's sampling method unfairly inflated the liability based on sales to a different customer ("Customer 2").

The government exemption requires the government's own credit, not a contractor's. Va. Code § 58.1-609.1 4 exempts tangible personal property for use or consumption by the Commonwealth, its political subdivisions, or the United States. But 23 VAC 10-210-690 A limits that exemption to sales made pursuant to a required official purchase order paid from public funds -- sales without that purchase order, or not paid from public funds, are taxable. Virginia is also bound by the federal court decision in United States v. Forst, 442 F. Supp. 920 (W.D. Va. 1977), aff'd 569 F.2d 811 (4th Cir. 1978): to claim an exemption on a client's behalf, a purchaser must be designated as that client's purchasing agent with authority to bind the client's credit.

Why Form ST-12 didn't save this sale. The taxpayer had a Form ST-12 -- filled out by a government agency -- on file, but the invoices for the disputed sales were billed to and paid by Customer 1, a government contractor, not the agency itself. Form ST-12 is for the exclusive use of government entities making their own exempt purchases; it does not pass through to a contractor buying on the government's behalf (P.D. 15-100, P.D. 20-57). Since Customer 1 -- not the government -- was the actual purchaser here, the certificate didn't validate the exemption.

Cost-reimbursement contracts don't bind the government's credit either. After the audit closed, the taxpayer produced a letter showing Customer 1 was authorized to use government supply sources under a cost-reimbursement contract. That still doesn't qualify: under a cost-reimbursement arrangement, the government isn't directly bound to pay the vendor -- it separately reimburses the contractor afterward for costs incurred fulfilling the contract. Because the government's credit isn't bound directly, the exemption doesn't apply to cost-reimbursement purchases (P.D. 06-137, P.D. 10-137).

The sampling challenge also failed. Separately, the taxpayer wanted Customer 2's sales excluded from the audit sample as unrepresentative, and the error factor recomputed against product sales only rather than total revenue. Sampling is a well-established audit technique, and a taxpayer seeking to remove a transaction from a sample must show it was isolated in nature and not a normal part of its operations (P.D. 00-164, P.D. 05-82). Here, the taxpayer admitted the Customer 2 sales were typical of its business, and the sample turned up other untaxed sales too -- meaning similar errors likely exist outside the sample period as well. The Department also noted that recomputing the error factor the taxpayer's preferred way would likely have produced a similar overall liability anyway.

Outcome. Both arguments failed, and the assessment was upheld in full, with an updated bill (interest accrued) and 30 days to pay before further interest accrues.

What this means for you

Government contractors and subcontractors making purchases on a government client's behalf

The government sales exemption travels with an actual, direct government purchase order paid from public funds -- it does NOT automatically extend to you as a contractor, even if you're procuring items for a government program. You need to be your client's designated purchasing agent with authority to bind the government's own credit, per United States v. Forst -- not merely authorized to use government supply sources.

Vendors accepting Form ST-12 from a customer who isn't itself the government entity

Confirm the actual purchaser and payer on the invoice is the government entity itself. A certificate filled out by a government agency doesn't validate a sale where a contractor -- not the agency -- is billed and pays. (Compare this to P.D. 26-27, where a dealer who accepted a properly completed ST-12 in good faith directly from the actual government buyer was protected -- the difference here is that the actual purchaser wasn't the government at all.)

Contractors working under cost-reimbursement contracts

Don't assume the government exemption applies just because your contract lets you use government supply sources or promises reimbursement. If the government isn't directly and immediately bound to pay the vendor, the exemption doesn't reach the purchase.

Anyone disputing an audit sample as unrepresentative

You must show the disputed transactions were truly isolated and atypical of your normal operations -- admitting the transactions were "typical," as happened here, forecloses the argument. Also expect the Department to check whether your proposed recalculation would actually change the bottom line before granting relief.

Common questions

Q: I'm a government contractor -- can I buy tax-exempt using my government client's exemption?
A: Only if the purchase is made pursuant to a required official government purchase order paid directly from public funds, and you're designated as the government's purchasing agent able to bind its credit (the Forst test). Simply working for or supplying the government isn't enough.

Q: My contract is a cost-reimbursement contract with the government -- does that qualify for the government exemption?
A: No. Under a cost-reimbursement contract, the government isn't directly bound to pay the vendor; it reimburses the contractor afterward. That indirect arrangement doesn't satisfy the exemption's requirement that the government's credit be bound directly.

Q: The auditor sampled my sales and found some untaxed transactions -- can I get a transaction excluded from the sample?
A: Only if you can show it was isolated and not a normal part of your business. If you concede the transaction type is typical for your operations, that argument fails.

Citations and references

Statutes and regulations:

• Va. Code § 58.1-609.1 4 -- exemption for tangible personal property for use or consumption by the Commonwealth, its political subdivisions, or the United States
• 23 VAC 10-210-690 A -- government sales are exempt only pursuant to required official purchase orders paid from public funds; sales without such purchase orders are taxable

Case law: United States v. Forst, 442 F. Supp. 920 (W.D. Va. 1977), aff'd 569 F.2d 811 (4th Cir. 1978) (a purchaser must be designated as its client's purchasing agent, authorized to bind the client's credit, to claim the client's tax exemption).

Authorities the Department relied on (described here, not linked): P.D. 15-100 (5/11/2015) and P.D. 20-57 (4/6/2020) (Form ST-12 is for exclusive use by government entities; no pass-through to third-party contractors); P.D. 06-137 (10/30/2006) and P.D. 10-137 (7/12/2010) (the government exemption doesn't apply to cost-reimbursement contracts); P.D. 00-164 (8/31/2000) and P.D. 05-82 (6/8/2005) (a transaction must be isolated and atypical to be removed from an audit sample).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 24-115

Original ruling text

November 14, 2024

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 March 2017 through February 2020. I apologize for the delay in responding to your request.

FACTS

The Taxpayer, a government contractor, provides IT consulting services and makes sales of hardware and software to government agencies and other entities. An audit by the Department resulted in an assessment for untaxed sales during the audit period. The Taxpayer filed an application for correction contending that sales made to * (Customer 1) were exempt because it acted as an agent of the United States government. The Taxpayer also contests the sampling method used to conduct the audit with regard to *** (Customer 2) claiming it is not representative of the population.

DETERMINATION

Government Sales

Virginia Code § 58.1-609.1 4 provides an exemption from the retail sales and use tax for tangible personal property for use or consumption by the Commonwealth, any political subdivision of the Commonwealth, or the United States. This provision is interpreted in Title 23 of the Virginia Administrative Code (VAC) 10-210-690 A, which provides:

Sales to the United States, or to the Commonwealth of Virginia or its political subdivisions, are exempt from the tax if the purchases are pursuant to required official purchase orders to be paid out of public funds . Sales made without the required purchase orders and not paid for out of public funds are taxable. Sales to governmental employees for their own consumption or use in carrying out official government business are taxable. [Emphasis added.]

Additionally, in determining the application of the tax on purchases by contractors, the Department is bound by the federal court's decision in United States v. Forst , 442 F. Supp. 920 (W.D. Va. 1977), aff’d., 569 F. 2d 811 (4th Cir. 1978), wherein the Court ruled that one must be designated as its client's purchasing agent and authorized to bind the credit of its client in order to take advantage of any exemption that applies to such client.

In the instant case, the Taxpayer failed to charge tax on sales made to Customer 1. During the audit, the Taxpayer provided the auditor with a Form ST-12, which was filled out by a government agency. The auditor included the untaxed sales in the audit because the invoices for the transactions at issue were billed to and paid for by Customer 1 rather than the government agency.

Form ST-12 is an exemption certificate for exclusive use by governmental entities to make exempt purchases from retail vendors. In this case, the Taxpayer did not make an exempt sale to a government entity. Instead, the Taxpayer made an untaxed sale to Customer 1, who is a government contractor. The exemption certificate is not valid for the transactions at issue because Customer 1 was not a government entity. See Public Document (P.D.) 15-100 (5/11/2015) and P.D. 20-57 (4/6/2020). These determinations conclude that Form ST-12 is to be used exclusively by governmental entities to make exempt purchases from retail vendors and there is no pass-through of the government exemption to third parties.

After the conclusion of the audit, the Taxpayer was able to locate a letter that purportedly shows Customer 1 made purchases as an agent of the federal government. The letter provided by the Taxpayer does not show proof of direct government payment for the sales at issue. Instead, the letter authorizes the customer to use government supply sources in performing government cost-reimbursement contracts.

The government exemption does not apply to cost reimbursement contracts, because the government's credit is not bound directly. Instead, the government is obligated to reimburse the contractor or vendor for the cost to procure tangible personal property that will be used in fulfillment of the contract. See P.D. 06-137 (10/30/2006) and P.D. 10-137 (7/12/2010).

Sampling

The Taxpayer also requests the removal of sales to Customer 2 from the sample, reasoning that the sales are not representative of the population. The Taxpayer believes that the sales are isolated in nature because it typically makes exempt sales. The Taxpayer also argues that the error factor produced an inaccurate result because it was applied to the Taxpayer’s total revenues resulting in an overstated liability. Instead, the Taxpayer asserts the error factor should have been applied only to total product sales.

Sampling is an audit technique of significant value that is widely used in both the public and private sectors for all types of audits where a detailed audit would not prove beneficial either to the auditor or the client. When sampling techniques are properly applied, the final results are usually within a narrow percentage range of the actual amount that would have been determined by a detailed audit. The purpose of the audit sample is to determine a factor for errors within a representative selected period. Once the error factor is determined, the factor is extrapolated over the entire audit period. The purpose of the projection is to account for likely similar transactions on which Virginia tax has not been paid.

For an item to be removed from the audit sample, the Taxpayer must show that the transaction was isolated in nature and not a normal part of the Taxpayer's operation. See P.D. 00-164 (8/31/2000) and P.D. 05-82 (6/8/2005). In this case, the transactions at issue were a normal part of the Taxpayer’s operations because the Taxpayer typically makes sales of this nature. In fact, the Taxpayer admitted that the sales included at audit were typical in nature to other transactions in the conduct of its business. In addition, the transactions are not isolated because there were other untaxed sales discovered during the audit. Although the Taxpayer claims that all other sales made during the audit period were made with valid exemption certificates on file, the fact that errors were found in the sample period means there may be other untaxed sales outside of the sample period, which are not included in the audit liability.

In addition, if the error factor was calculated using the Taxpayer’s suggested method, the measure would not accurately reflect the Taxpayer’s overall business and the error factor would have to be revised to reflect the smaller sample population. Even if the Taxpayer’s requested method was used, the application of a recomputed error factor would likely result in a similar audit liability because the error factor would have had to have been applied to the same limited revenue stream.

CONCLUSION

Based on the authorities cited above, and in the evidence provided, the Taxpayer has failed to show that the sales qualify for exemption from tax. In addition, the evidence shows the sampling method and error factor were appropriately applied by audit staff. Accordingly, the assessment is upheld. The Department will mail an updated bill shortly, with interest accrued to date. No further interest will accrue provided the outstanding assessment is paid within 30 days from the date of this letter.

The Code of Virginia sections and regulation cited are available online at law.lis.virginia.gov. The public documents 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, Appeals and Rulings, at (804) or **@tax.virginia.gov

Sincerely,

James J. Alex

Tax Commissioner

Commonwealth of Virginia

Related Documents

00-164

05-82

06-137

10-137

15-100