Federal Contractor Required to Pay Washington Use Tax on Design and Engineering Costs Associated with Government Contract

The Court of Appeals of Washington determined that Alstom Power Inc. was required to pay Washington use tax for a turbine rehabilitation project. Alstom contracted with the federal government through the U.S. Army Corps of Engineers to complete turbine rehabilitation work. The contract required that Alstom complete initial design work prior to the Army Corps approving and authorizing the physical work on the rehabilitation and installation of the turbine components. Under the contract, Alstom wouldn’t be paid until the government approved the project design. Alstom subcontracted with one of its affiliates to design, engineer and manufacture the turbine components.

The Washington Department of Revenue (DOR) audited the project and the Board of Tax Appeals (Board) determined that Alstom owed Washington use tax on the design and engineering costs associated with the creation and rehabilitation of turbine components because those costs were part of the value of the turbine components. The Board limited the inclusion of the design and engineering costs to only those that postdated the Army Corps’ authorization of the rehabilitation. The Board determined that pre-authorization costs should not be included in the value of the turbine components because of the contract provisions. Alstom and the DOR both appealed the Board’s order. Alstom argued that it shouldn’t owe use tax on the design and engineering costs. The DOR argued that the Board shouldn’t have excluded the pre-authorization design and engineering costs from the taxable value.

The Court of Appeals affirmed the Board’s determination that the design and engineering costs are included in the value of the turbine components for Washington’s use tax. The Court of Appeals also reversed the Board’s determination that the pre-authorization costs are not also included in the taxable value of the turbine components.

The judge stated that under Washington tax law, because federal contractors may not impose sales tax on the federal government, federal contractors are required to pay use tax on the value of the materials and tangible personal property used for the government contract. “Value” is defined as “the purchase price for the article of tangible personal property,” which includes its design and engineering costs.

Per the court’s opinion, Alstom essentially purchased the turbine components from its subcontractors, paying for both the raw materials and the design and engineering work. Because Alstom purchased and incorporated turbine components into the turbines, they became the “articles used” for the project. As the articles used, Washington tax law dictates that Alstom must pay use tax on a value equivalent to a retail selling price, which like any purchased product, would necessarily include the costs to design and engineer the components.

(Alstom Power Inc. v. Washington, Wash. Ct. App., Div. 2, No. 56476-9-II, March 28, 2023)

Posted on April 11, 2023