The Virginia Tax Commission released a letter ruling regarding a flooring company that incorrectly classified itself as a retailer while operating as both a retailer and contactor under Virginia law. The taxpayer, a company that remained anonymous in the ruling, was audited for the period of August 2018 through July 2021; the auditor determined that the taxpayer was actually a dual operator—a retailer and a consuming contractor—and assessed use tax on untaxed purchases that were used in performing contractor services. The taxpayer contended that they had correctly classified themselves as a retailer, they were unaware of certain changes in Virginia law, and that they had remitted sales and use taxes, so they should receive some tax credit.
Contractors in Virginia are governed by Virginia Code § 58.1-610 A, which states a person who makes a contract to perform construction, including installation or repairs, and to provide the property used for that construction is considered to have purchased the property for use. The Virginia Code goes on to detail that any property sold to a contactor should not be considered a sale for retail, and the dealer of the property should collect sales tax from the contractor. Title 23 of the Virginia Administrative Code (VAC) 10-210-410 A further interprets § 58.1-610 A, saying that tangible personal property becomes real property as it is incorporated into real property, and that the contractor uses the property rather than resells the property. Based on the audit filing, the taxpayer in this case was both a retailer of floor covering materials and supplies and a consuming contractor who installs the same, which in Virginia is classified as a dual operator. Dual operators are subject to Title 23 VAC 10-210-410 B, which concludes that applicable contractors are dealers who must obtain a Certificate of Registration, and may purchase tangible personal property for resales as long as it is not for a specific project at the time of purchase, and then if the property is used for a contracting project, the use tax must be paid by the contractor on their tax return.
This taxpayer was directly impacted by a tax change passed by the Virginia legislature. Before July 2017, contractors would purchase items such as floor coverings, blinds, cabinets, and similar supplies for resale and then charge sales tax to customers. However, in July 2017, the provision of Virginia Code § 58.1-610 requiring this, was repealed, and this process shifted to the current process, where use tax is paid by contractors. Though the auditor correctly classified the taxpayer, since the taxpayer had incorrectly classified itself and charged sales and use tax to customers, which it then remitted to the state, the taxpayer claimed remitting additional tax would be double taxation. Under Title 23 VAC 10-210-410, though, erroneous collection of sales tax does not eliminate the use tax responsibility for the contractor. If an audit determines only sales tax was remitted, the contractor will receive a use tax assessment for unpaid tax because the sales tax transaction is a separate transaction from the use tax transaction. Contractors are only entitled to refunds for sales tax when they can show the incorrectly collected tax was paid by the contractor and not passed on to the customer (or that the tax was refunded to the customer if it was passed on). The reason for only limited circumstances for credits is that the Virginia Department of Taxation determined that allowing broader credit application would both authorize contractors to pay their liabilities with customers’ sales tax payments and would allow contractors to avoid responsibility for violating Virginia Code § 58.1-610.
In this case, Virginia Code § 58.1-1812 C (effective July 1, 2024) offers some relief to the taxpayer. Under this section, if a contractor has incorrectly collected and remitted sales tax on property that should have been subject to use tax, a one-time credit can be permitted against the use tax assessment for only the first offense. To receive the credit , a contractor must show the property in question was the same specific property that was included in sales tax calculations. Credit cannot be given if the contractor has previously received this credit or in situations where the contractor is taking fraudulent action to avoid tax responsibility. For audits concluded prior to July 1, 2024, the contractor is required to complete and submit an offer for the credit amount on Form OIC B-2. For audits concluded on or after July 1, 2024, the audit staff is required to calculate the amount of credit. As a result of these requirements, to claim the credit, auditors must be given access to the contractor’s complete records, both purchases and sales, to determine any credit amount. Auditors can work with contractors to find alternative ways to verify credits in the event business records are unavailable. Since this first offense is likely to be during an audit, and can only be claimed once, auditors may also extend the audit period to cover all periods with incorrectly collected sales tax.
The conclusion of the letter ruling is that the auditor correctly determined the taxpayer was a dual operator who inaccurately charged, collected, and remitted sales tax on transactions that should have been subject to use tax, but that the taxpayer is entitled to some relief under the one-time credit. The audit will be returned to field audit staff to review the credit and adjust the assessment appropriately. Further, the ruling gave an option for the credit to be extended, along with the audit, to give the taxpayer time to update their accounting system to be compliant with Virginia sales and use tax requirements. The taxpayer was instructed to either pay sales tax to vendors or to accrue use tax on purchases used for the contracting business going forward, and they were reminded another credit will not be granted.
This letter ruling highlights the importance of being aware of changes in tax laws in each state. The taxpayer in this case was unaware of an important law change, which completely changed the tax process for one portion of their business and did not update how they were handling taxation of customers for contracting jobs. However, Virginia allows for one time amnesty in this situation if certain requirements are met. More awareness of the tax laws would have left the taxpayer more prepared for the audit and would have avoided a surprise use tax bill. The specifics of the amnesty credit in this case are important to note. Taxpayers who may be able to take advantage of this one-time credit will want to be aware of the exact reporting requirements so they can receive the most accurate credit possible for previously remitted tax. (Letter Ruling number 24-123, issued November 18, 2024, Signed Alex, James J., Tax Commissioner, Commonwealth of Virginia)