Can a direct pay permit holder claim a use-tax refund based on an estimated accrual percentage, and must the Department run an audit to find the overpayment?

Plain-English summary

A materials-science manufacturer held a direct pay permit — a Department authorization that lets certain businesses buy without paying sales tax to their vendors and instead remit use tax directly to the state when they later put items to a taxable use. Instead of tracking tax item-by-item, the company remitted use tax using an "estimated accrual percentage" (essentially an error factor applied to its purchases). After an internal review it concluded it had been overpaying, and it asked the Department for a refund — and, when that was denied, asked the Department to run a full audit to figure out the overpayment.

The Commissioner denied the refund and declined to audit. The reasoning:

• A direct pay permit means transaction-by-transaction accrual. Under Va. Code § 58.1-624 and 23 VAC 10-210-920 F, a permit holder accrues use tax on the actual cost price of each specific taxable item it uses. Estimating with an error factor is not permitted under the direct-pay framework.
• The only exception is a "front-end agreement." The Department does allow some manufacturers/permit holders to remit on an error-factor basis, but only under a written front-end agreement (the arrangement recognized in Reynolds Metals Co. v. Commonwealth, published as P.D. 01-11). This company did not have one, so its estimated method had no legal basis.
• Sales and use tax is a transactional tax. To get a refund you must show, transaction by transaction, that tax was actually accrued and paid on specific exempt items (Va. Code § 58.1-623 A puts the burden on the taxpayer/dealer). The company submitted no transaction-specific documentation, so the Department couldn't validate any overpayment.
• The burden is on the taxpayer. An assessment (or a denial) is prima facie correct (§ 58.1-205), and because the refund claim rested on an unapproved estimate, the Department was not obligated to perform an audit to prove the taxpayer's own overpayment.

What this means for you

Direct pay permit holders

Your permit is not a license to estimate. Accrue and remit use tax on the actual cost of each taxable item you use. If you want to remit on an error-factor/estimated basis (common in high-volume manufacturing), you must negotiate a written front-end agreement with the Department first — retroactively claiming one won't work.

Anyone seeking a Virginia sales/use tax refund

Refunds are proven one transaction at a time. Keep invoices and records showing tax was paid or accrued on the specific transactions you say were exempt or overpaid. A top-down "we think we overpaid by X%" claim, with no transaction documentation, will be denied — and the Department will not run an audit to build your refund for you.

Tax professionals

This ruling ties three doctrines together: the narrow scope of direct-pay accrual, the front-end-agreement exception (Reynolds Metals / P.D. 01-11), and the transactional-tax rule requiring transaction-level substantiation for refunds. Advise permit-holder clients to paper a front-end agreement before using estimated accruals, and to preserve transaction-level records for any refund posture.

Common questions

Q: I have a direct pay permit. Can I estimate my use tax with an accrual percentage?
A: Not on your own. You must accrue tax on the actual cost of each taxable item used, unless you have a written front-end agreement with the Department authorizing an error-factor method.

Q: What is a "front-end agreement"?
A: A written agreement (recognized in Reynolds Metals Co. v. Commonwealth) under which a direct pay permit holder may remit tax based on an error factor applied to certain accounts payable data where taxability can't be determined at purchase. Without it, the estimated method isn't allowed.

Q: I think I overpaid use tax. Will the Department audit me to issue a refund?
A: No. Because sales and use tax is a transactional tax, you must supply transaction-specific documentation proving the overpayment. The Department is not obligated to audit you to determine the accuracy of an estimated accrual percentage.

Q: Who has the burden of proof on a refund claim?
A: You do. Transactions are presumed taxable until the contrary is shown (§ 58.1-623 A), and a Department determination is prima facie correct (§ 58.1-205).

Citations and references

Statutes and regulations:

• Va. Code § 58.1-624 — direct pay permits; qualifying taxpayers pay the sales and use tax directly to the Department
• 23 VAC 10-210-920 F — direct pay permit procedures; accrual on the cost price of the specific item used
• Va. Code § 58.1-623 A — all sales/leases presumed taxable until the contrary is established; burden of proving non-taxability on the dealer
• Va. Code § 58.1-205 — an assessment/determination is prima facie correct; burden on the taxpayer

Case law and prior documents (described here rather than linked): Reynolds Metals Co. v. Commonwealth (Augusta Cir. Ct. 2000), published as P.D. 01-11, recognizing front-end agreements for direct pay permit holders; P.D. 00-100 and P.D. 25-30 stating the retail sales and use tax is a transactional tax; and out-of-state decisions the Department cited for the transactional-tax doctrine (KSS Transp., Monarch Beverage, Matrix Funding, Woodmen of the World).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 26-21

Original ruling text

April 21, 2026

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

Dear *:

This is in response to your letter submitted on behalf of * (the “Taxpayer”) in which you dispute the denial of a retail sales and use tax refund for the period May 2021 through April 2024.

FACTS

The Taxpayer, a materials science company, submitted a refund request for the period at issue. The Taxpayer held a direct pay permit, which allows it to pay any tax due to the Department directly instead of remitting the tax to vendors. During the period at issue, the Taxpayer used an estimated accrual percentage that had been used to calculate its use tax liability. Based on an internal review, the Taxpayer concluded that it had been overstating its use tax liability.

Under review, the Department denied the refund request because the Taxpayer had not received permission to use an estimated accrual percentage to determine its monthly use tax accrual. The Taxpayer filed an application for correction requesting that the Department perform a full audit in order to determine the amount of any overpayment of use tax.

ANALYSIS

Direct Pay Permits

The Taxpayer was authorized to use a direct pay permit by the Department. Virginia Code § 58.1-624 and Title 23 of the Virginia Administrative Code (VAC) 10-210-920 F allow certain taxpayers to apply for and use a direct pay permit to pay the Virginia retail sales and use tax directly to the Department when it is not possible at the time tangible personal property is purchased to know how it will be used. When a direct pay permit is granted, the taxpayer must file copies of the permit with dealers in order to make purchases without paying retail sales and use tax. The validity of such a permit is perpetual unless surrendered by the taxpayer or cancelled for cause by the Department.

Under a direct pay permit, a taxpayer usually makes purchases exempt from the tax and then accrues tax on taxable items when they are put into use or consumed. The accrual is based on the cost price of the specific item used in a manner that is taxable under Virginia’s sales and use tax statutes.

In this instance, instead of accruing tax based on the use of taxable items, the Taxpayer used an error factor to estimate the amount of tax remitted to Virginia. As indicated above, no basis for such a computation is permitted under the statutory framework for direct pay permits. The only taxpayers permitted to use such a method are those that have ratified a front-end agreement with the Department.

Front-End Agreements

Front-end agreements have been used for taxpayers that are manufacturers or holders of direct pay permits. See Reynolds Metals Company v. Commonwealth of Virginia , (Augusta Cir. Ct., March 21, 2000), published as Public Document (P.D.) 01-11 (10/19/2001). The agreement usually covers the expense purchase portion of the audit. Under a written agreement with the Department, a direct pay permit holder may agree to remit tax based on an error factor on certain accounts payable data for which taxability cannot be determined at the time of purchase, and for amounts in certain accounts in which all the activity is deemed taxable. The Taxpayer, a manufacturer, did not have a front-end agreement with the Department.

Refund Claim

Virginia Code § 58.1-623 A sets out that all transactions involving the sale or lease of tangible personal property are subject to the tax until the contrary is established. Under this statute, “the burden of proving that a sale, distribution, lease, or storage of tangible personal property is not taxable is upon the dealer …” Thus, to be eligible for a refund, a taxpayer must be able to show that either sales or use tax was accrued and paid on specific exempt transactions.

The Department’s longstanding policy has held that the retail sales and use tax is a transactional tax. See P.D. 00-100 (5/25/2000) and P.D. 25-30 (2/27/2025). This is consistent with a number of court decisions. See KSS Transp. Corp. v. Baldwin, 9 N.J. Tax 273 (1987); Monarch Beverage Co. v. Indiana Dep't of State Revenue , 589 N.E.2d 1209 (1992); Matrix Funding Corp. v. Utah State Tax Comm'n, 2002 UT 85 (2002), and Woodmen of the World Life Ins. Soc'y v. Neb. Dep't of Revenue , 299 Neb. 43 (2018). In accordance with this doctrine, the Department reviews transactions based on the documentation presented for each transaction, and the determination as to the taxation of each specific transaction is based on the underlying documents that support the transaction. Thus, documentation must be provided to prove that the tax was paid to a vendor or accrued and remitted to the Department for each transaction. Because the Taxpayer did not submit transaction-specific documentation, the Department is unable to ascertain the validity of the refund request.

DETERMINATION

Virginia Code § 58.1-205 provides that any assessment of tax by the Department is deemed to be prima facie correct and that the burden is on the taxpayer to prove the assessment is erroneous or incorrect. In accordance with the facts provided and the authorities cited, the Department appropriately denied the Taxpayer’s request for a refund.

In addition, while the Taxpayer filed a refund claim for the period at issue, the claim was based on an estimated accrual percentage for which it failed to obtain an upfront agreement. As such, the Department is not obligated to perform an audit to determine the accuracy of the Taxpayer’s estimated accrual percentage.

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 and Legal Affairs, Tax Adjudication and Resolution Division, at or **.

Sincerely,

Kristin L. Collins
Tax Commissioner
Commonwealth of Virginia

AR/5238.Z

Related Documents

00-100

01-11

23-89

25-30