I provide broadband internet service and the Department denied part of my sales tax refund on equipment purchases because I sell wholesale, not retail -- but a court case said that shouldn't matter. Does my refund get reconsidered?

Plain-English summary

A broadband internet provider sought a refund of Virginia sales and use tax it had paid on equipment purchases for October 2011 through December 2012. The Department had granted part of the refund but denied the rest, and the taxpayer challenged four separate pieces of that denial.

A court decision reopened the core exemption question. Virginia's ISP sales tax exemption (Va. Code § 58.1-609.6 2, reaching ISPs through the "amplification" definition in § 58.1-602) exempts equipment used to provide internet-access services. For years, the Department's own policy (across six prior rulings) required that a provider make retail sales of the service -- not wholesale -- to qualify. In 2021, a Richmond circuit court disagreed in Alcatel-Lucent USA Inc. v. Virginia Department of Taxation, holding the exemption is NOT limited to equipment used for retail sales. Because of that decision, the Department must reconsider this taxpayer's refund claim under the broader standard -- potentially unlocking exemption for wholesale-service equipment that was previously denied.

Mixed-use equipment must still be prorated -- "100% dedicated" isn't the same as "100% exempt." Separately, the taxpayer argued its equipment serving BOTH exempt internet functions and non-exempt functions (like telephone service) should be fully exempt, because the equipment is "dedicated 100% of the time" to providing uninterrupted internet service even while also handling other traffic. The Department rejected that theory: equipment used for both an exempt and a non-exempt purpose must have its tax prorated between the two uses -- the ISP exemption has no "predominant use" threshold (unlike some other Virginia exemptions that only require 50%+ exempt use), so any non-exempt use requires apportionment, not a free pass. The Department will, however, consider the taxpayer's own PROPOSED allocation percentage as an alternative to the revenue-based method it had been using.

Refund interest was underpaid -- more is due. On review, the Department agreed it had understated the interest owed on the portion of the refund already granted, and additional interest will be paid.

Some excluded transactions stay excluded for lack of verification. The taxpayer argued it shouldn't have had to submit the vendor certification forms the Department's June 2017 refund guidelines require, since its refund claim predated those guidelines -- and the Department agreed it wasn't bound by that specific form requirement. But the Department still needs SOME way to confirm (1) that sales tax was actually charged and remitted on a given purchase, and (2) which locality the tax was originally paid to (since local tax portions must be allocated back to the correct locality). Where the taxpayer couldn't provide alternative proof and the vendor's own filings didn't support the claimed amount or locality, those transactions properly stayed excluded from the refund.

What happens next. The whole case goes back to the Department's audit staff to recalculate the refund under the broader ISP exemption standard and the taxpayer's proposed mixed-use allocation percentage, with updated interest. The auditor will request any further information needed and issue an updated report explaining any changes.

What this means for you

Internet service providers with pending or past refund denials based on "retail sales only"

If your ISP exemption claim was ever denied (fully or partly) because your sales were wholesale rather than retail, revisit it -- the 2021 Alcatel-Lucent court decision struck down that limitation, and this ruling shows the Department applying the broader standard on reconsideration.

ISPs and telecom providers with equipment serving multiple functions

Don't assume equipment is fully exempt just because it's continuously dedicated to an exempt service -- if the SAME equipment also handles a non-exempt function (like voice/telephone traffic), the tax must be prorated between the two uses. Come prepared with your own time- or usage-based allocation methodology if you think it's more accurate than a revenue-based split.

Businesses whose refund claim predates the Department's 2017 vendor certification guidelines

You may not be bound by the specific certification-FORM requirement if your claim predates it, but you still need to be able to show, some other way, that the tax was actually charged, remitted, and tied to the correct locality -- or those transactions will stay excluded regardless.

Common questions

Q: My ISP refund claim was denied because I only make wholesale, not retail, internet sales -- is that still the rule?
A: No -- a 2021 Richmond circuit court decision (Alcatel-Lucent USA Inc. v. Virginia Department of Taxation) struck down the retail-only limitation, and the Department is now applying the broader standard on reconsideration of affected claims.

Q: My equipment runs 100% of the time providing internet service, even though it also handles other traffic -- shouldn't it be fully exempt?
A: No. Constant operation doesn't equal full exemption if the same equipment also performs a non-exempt function. The tax must be prorated between the exempt and non-exempt uses.

Q: My refund claim predates the Department's 2017 vendor certification form guidelines -- do I still need to prove my purchases?
A: You're not bound by that specific FORM requirement, but you still need some way to show the tax was actually charged, remitted, and allocated to the correct locality -- without that, the transaction can still be excluded.

Citations and references

Statutes and budget language:

• Va. Code § 58.1-609.6 2 -- broadcasting/amplification/transmission/distribution/network equipment exemption, extended to ISPs
• Va. Code § 58.1-602 -- defines "amplification" to include equipment used to provide Internet-access services
• 2024 Appropriation Act Item 3-5.04 (and predecessor budget language dating to the 2006 Appropriation Act) -- the ISP exemption is administered as a refund request to the Tax Commissioner, not a point-of-sale exemption

Case law: Alcatel-Lucent USA Inc. v. Virginia Department of Taxation, CL20-3591-7 (Cir. Ct. City of Richmond, 10/26/2021), published as P.D. 21-171 (5/11/2022) -- struck down the Department's retail-sales-only limitation on the ISP exemption.

Prior rulings the Department relied on (described here, not linked): P.D. 00-18, P.D. 01-29, P.D. 13-179, P.D. 16-167, P.D. 20-80, P.D. 20-81, and P.D. 20-82 (the now-overturned retail-only ISP exemption policy); P.D. 93-202 (predominant-use exemptions requiring 50%+ exempt use, distinguished here since the ISP exemption has no such threshold); P.D. 88-331, P.D. 13-136, P.D. 92-28, P.D. 93-229, and P.D. 96-238 (proration methodology for mixed-use equipment, including revenue-based allocation); P.D. 17-98 (6/12/2017) (Guidelines for Retail Sales and Use Tax Refund Claim Procedures, including vendor certification forms).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 24-90

Original ruling text

September 18, 2024

Re: § 58.1-1821 Refund Application: Retail Sales and Use Tax

Dear *:

This is in response to your letters submitted on behalf of * (the “Taxpayer”), in which you seek a refund of the retail sales and use tax for the periods October 2011 through December 2012. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer, a provider of broadband services to customers in Virginia, filed retail sales and use tax refund requests related to various equipment purchases. The Department granted a portion of the request. However, the denial of the remaining balance of the request resulted from the Taxpayer’s failure to show that it made retail sales of services as required by the existing Internet Service Provider (ISP) exemption policy. The Taxpayer submitted applications for correction citing a Virginia circuit court decision that overturned the Department’s prior policy. The Taxpayer also disputed the allocation percentage applied by the Department to its mixed-use equipment, the vendor certification form requirement, and the denial of interest paid on the refunds that were granted.

DETERMINATION

ISP Exemption

Virginia Code § 58.1-609.6 2 provides an exemption from Virginia’s retail sales and use tax for broadcasting equipment, including parts and accessories, and towers used by commercial radio and television companies, cable television systems, common carriers or video programmers using an open video system or other video platform provided by telephone common carriers, or other entities that are under the regulation and supervision of the Federal Communications Commission. The exemption also applies to amplification, transmission, distribution, and network equipment used by wired or land-based wireless cable television systems, open video systems, or telephone common carriers. ISPs are eligible for the exemption because the definition of “amplification” under Virginia Code § 58.1-602 includes “production, distribution, and other equipment used to provide Internet-access services.”

The Department previously interpreted the ISP exemption to require that a provider make retail sales rather than wholesale sales of services to qualify. See Public Document (P.D.) 00-18 (3/17/2000), P.D. 01-29 (3/29/2001), P.D. 13-179 (10/11/2013), P.D. 16-167 (8/26/2016), P.D. 20-80 (5/12/2020), P.D. 20-81 (5/12/2020), and P.D. 20-82 (5/12/2020). However, the Circuit Court for the City of Richmond disagreed, holding that the ISP exemption is not limited to equipment used to provide retail sales of the relevant services. See Alcatel-Lucent USA Inc . v. Virginia Department of Taxation , CL20-3591-7, (10/26/2021), published as P.D. 21-171 (5/11/2022). Accordingly, the Taxpayer’s refund claim must be reconsidered.

Mixed-Use Equipment

The Taxpayer argues it is entitled to full exemption for qualified equipment purchases because it was used exclusively for the provision of internet services. It has been the Department’s experience that equipment eligible for the exemption under Virginia Code § 58.1-609.6 2 can and has been used in services for which the exemption is available and in services ineligible for an exemption. For example, while equipment used for transmission of television signals is exempt, equipment used for transmitting telephone services is not. Because these service providers have often bundled services, the same equipment can be used to provide both services that qualify for the exemption and services that do not.

Some sales and use tax exemptions include a predominant use requirement, where the transaction is exempt so long as the tangible personal property will be used more than 50% of the time for an exempt purpose. See, e.g., P.D. 93-202 (9/27/2003). The ISP exemption does not require predominant use in an exempt manner in order for the exemption to apply. With such exemptions, when tangible personal property is used for purposes beyond the scope of the exempting language, the relief is limited to the tax attributable to the exempt purpose of the property. In other words, the tax must be prorated when the equipment is used in both exempt and taxable activities. See P.D. 88-331 (12/16/1988)

For retail sales and use tax purposes, the proration methodology is generally based on the percentage of time the property is used in a taxable activity and the percentage of time the property is used in an exempt activity. However, when it is not possible to prorate the tax in this manner, another approach may be considered. See P.D. 13-136 (7/18/2013). The Tax Department has previously determined that the percentage of time may be calculated by using revenue derived in exempt activities versus the revenue derived in taxable activities. See P.D. 92-28 (4/20/1992), 93-229 (12/15/1993), and 96-238 (9/20/1996).

In this case, the Taxpayer maintains that its proposed time allocation percentage should be used to determine the sales tax on the mixed-use equipment, rather than the Department’s revenue-based allocation method. The Taxpayer contends that the equipment at issue is used to provide exempt activities 100% of the time. Specifically, the Taxpayer states that in order to provide uninterrupted Internet services, its mixed-use equipment is dedicated 100% of the time to the provision of Internet services. The Taxpayer further contends that the fact that a piece of equipment is performing more than one function at a time does not take away from the fact that the equipment is performing exempt activities all of the time. Based on this rationale, the Taxpayer contends that the equipment used to provide Internet services is exempt. As an alternative, the Taxpayer contends that the revenue-based allocation percentage used by the Department should be adjusted.

The Taxpayer admits that the equipment at issue is used in more than one activity. Equipment used in both exempt and taxable activities cannot be 100% exempt for sales and use tax purposes. As such, the Taxpayer’s contention that the mixed-use equipment is exempt because it is used 100% of the time to provide exempt services is without merit. The sales tax must be prorated on mixed-use equipment. However, the Department will consider the Taxpayer’s alternative allocation percentage in light of the ISP exemption policy change.

Interest

The Taxpayer disputes the amount of interest paid on its refund. After further review, the Department agrees refund interest was understated on the initial refund and that additional interest is due to the Taxpayer.

Vendor Certification Forms

The Taxpayer asserts that it was not required to comply with the refund guidelines published by the Department in June 2016. These guidelines require refund claimants to submit completed vendor certification forms to support the refund request. Rather, the Taxpayer contends that it provided sufficient proof sales tax was paid to each vendor, and that it is not required to provide proof the vendor remitted the tax to the Department.

During the refund verification process, the Department’s auditors requested that the Taxpayer have its vendors complete vendor certification forms. In instances where the certification forms were not provided, the auditor reviewed the vendors’ sales and use tax filings with the Department to determine whether a refund was warranted. If the gross sales amount was insufficient to have included the value of the invoice, the refund was denied. The refund was also denied if the locality information could not be verified or if the vendor did not file a return for the month in which the transaction took place.

In 2006, the Virginia General Assembly enacted language in the 2006 Appropriation Act (House Bill 5002, Chapter 3 of the 2006 Acts of Assembly, Special Session I ) regarding the sales and use tax exemption for Internet service providers for purchases made on or after July 1, 2006. Similar language has been reenacted by the General Assembly in subsequent budget bills since 2006. See Item 3-5.04 of the 2024 Appropriation Act (House Bill 6001, Chapter 2 of the 2024 Acts of Assembly, Special Session I ):

Notwithstanding any other provision of law, for purchases made on or after July 1, 2006, any exemption from the retail sales and use tax applicable to production, distribution, and other equipment used to provide Internet-access services by providers of Internet service, as defined in § 58.1-602, Code of Virginia , shall occur as a refund request to the Tax Commissioner. The Tax Commissioner shall develop procedures for such refunds.

On June 12, 2017, the Department issued Guidelines for Retail Sales and Use Tax Refund Claim Procedures (the “Guidelines”), published as P.D. 17-98 (6/12/2017). The Guidelines provide that a taxpayer must complete a Refund Claimant Return in order to receive a refund of a tax remitted to the Department by the dealer through whom a purchase of tangible personal property was made. The refund request spreadsheet and the vendor certification form must also be included with the Claimant Return. This information is used by the Department to assist in verifying the refund claimed by the Taxpayer.

When the Taxpayer filed its initial refund request, the Department had not yet established the Guidelines referenced above. Accordingly, the Taxpayer was not required to provide the vendor certification form as part of the review of its refund request by the Department.

Notwithstanding the foregoing, the Department must be able to verify the refund amount requested by the Taxpayer. Further, the Department must ensure that the local tax portion of the refund is allocated to the locality for which the tax was originally reported and paid. If the Department cannot verify the refund amount request or the locality, the refund cannot be granted. In this instance, transactions were excluded from the refund because it could not be verified if the sales tax was actually charged and remitted to the Department. Additionally, the Department could not verify the localities to which the sales tax was initially paid. On appeal, the Taxpayer has not proven its contention that the refund was erroneously denied. Accordingly, the transactions at issue were properly excluded from the refund.

CONCLUSION

The Taxpayer’s case will be remanded to the Department’s audit staff to reconsider the Taxpayer’s refund request in light of the change to the Department’s ISP exemption policy and this determination. Should the audit staff need additional information from the Taxpayer, the auditor will request the specific information needed and work with the Taxpayer in order to review the additional information at a mutually agreed-upon time. Once the audit staff’s review is completed, the auditor will send the Taxpayer an updated audit report and a written explanation of any changes to the approval or denial of the Taxpayer’s refund requests.

The Code of Virginia sections 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 via email at @tax.virginia.gov. If you have any questions regarding the audit staff’s review of the Taxpayer’s refund requests, please contact in the Office of Compliance, Field Audit, at (804) , or via email at ***@tax.virginia.gov.

Sincerely,

James J. Alex

Tax Commissioner

Commonwealth of Virginia

AR/3895.C

Related Documents

88-331

92-28

93-202

93-229

96-238

00-18

01-29

13-136

13-179

16-167

17-98

20-80

20-81

20-82

21-171